Expertise Beyond the Numbers

How Private Equity is Helping to Underwrite the Transformation of Healthcare

From the announcement that Amazon, Berkshire Hathaway and JPMorgan Chase will form a new healthcare company in response to CVS’ proposed acquisition of Aetna, there has been no shortage of headline-grabbing healthcare deals in recent months. Such transactions are remarkable not simply for their size—or the strength of the brands involved—but for signaling that the healthcare industry is on the threshold of transformational change.

While garnering far less media attention, there was another recent business development that promises to affect healthcare’s transformation far more than any single deal: The global private equity industry raised a record $453 billion in 2017, besting the previous high water mark of $414 billion set in 2007. According to consensus estimates, private equity funds are sitting on a record amount of “dry powder”—capital that has yet to be invested in companies and new business ventures—of more than $1 trillion.

Why Healthcare is Attractive to Private Equity Investors

Of course, not all of this capital will be earmarked for healthcare. Technology and consumer staples, among other industries, will invariably get their fair share, but healthcare will continue to be a uniquely attractive opportunity with private equity investors. According to a report by the American Investment Council, healthcare was the only industry in the U.S. to receive more private equity dollars in 2017 than 2016. For a variety of factors, we anticipate that healthcare will continue to be a prime focus of investors:

Staying power – According to the Centers for Medicare and Medicaid Services (CMS), health care represented 17.9 percent of the nation’s GDP in 2016—the last year for which such data are available. Also according to CMS, U.S. health care spending is projected to grow by an average 5.6 percent annually over the next decade and will constitute nearly 20 percent of the nation’s GDP by 2025.

Inefficiencies abound – By definition, any industry that constitutes such a vast swath of the national economy—and whose costs have historically outpaced the rate of inflation—is inefficient. According to a recent report published by the Journal of American Medicine, the U.S. spends nearly twice as much on healthcare on a per capita basis than 11 other high-income countries. Also, as more providers, including health systems and physician groups, assume financial risks in the delivery of care, these inefficiencies represent enticing economic opportunities.

An appetite for change – The debate and implementation of the Affordable Care Act, as well as the increasing pressure for providers and payers alike to improve patient outcomes, while reducing the overall cost of care, have prompted the industry to re-examine both the business and delivery of care. As the recent spate of mergers and acquisitions demonstrates, the private sector will continue to drive the necessary market-based reforms—many of which will be underwritten by private equity.

Where Private Equity Capital will be Invested

Healthcare is no stranger to private equity capital. Clayton, Dubilier & Rice acquired Envision Healthcare, formerly known as Emergency Medical Services Corporation, for $3.2 billion in 2011 and TPG Capital bought Par Pharmaceutical in 2012 for $1.9 billion. The volume of middle market healthcare transactions has been no less robust; notable deals in 2017 include Kohlberg Kravis Roberts & Co.’s $910 million investment in PharMerica and Linden Capital Partners’ and the Jordan Co.’s $770 million investment in Young Innovations.

A segment of the healthcare industry that is particularly ripe for private equity investors are hospitals, ambulatory care centers and physician groups. Not only do they represent roughly half of all healthcare spending in the U.S.—according to the Peterson-Kaiser Health System Tracker, hospital spending represented 32% of overall spending in 2016, while physicians/clinics represented 20%—they are in fundamental need of performance improvement.

Hospitals have been benefitting from private equity investments, but also their knowhow. With the backing of Cerberus Capital Management, Steward Health Care acquired eight hospitals from Community Health Systems in 2017 and Apollo Global Management acquired RCCH Healthcare in 2015. The latter transaction has been credited for created a stronger, more efficient system.

Similarly, as large not-for-profit health systems continue to merge to form mega-systems, they could benefit significantly by private equity-backed managers experienced in integrating large businesses and solving complex problems, in addition to having access to capital. For this reason, we anticipate additional transactions between health systems and private equity investors.

Physician groups are benefitting from private equity investments as well. As providers assume greater risk in caring for patients, the traditional business model for physician groups is upended. In addition to sharing the cost of patient care—and potentially the profit in doing so—many physician groups are now owning and operating ambulatory care centers. In so doing, they are responsible for the acquisition and maintenance of buildings and equipment, marketing and accounting support and other essential tasks for which they received little, if any training, in medical school.

Because healthcare increasingly favors providers with size, business acumen and access to capital, private equity investors often pair well with physician groups.

While not a complete listing of all the private equity deals which have occurred across every physician and ambulatory care platform, these deals do represent the broad array of specialties which have been involved with private equity recently:

Urology & Gastroenterology

In 2016, the Audax Group acquired Chesapeake Urology, while at the same time consummating a private equity partnership with Gastro Health (March 2016). The acquisition of Chesapeake Urology was the first private equity investment in urology which will lead to a consolidation in this highly fragmented market. Similarly, gastroenterology will continue to see consolidation. “Gastro Health is a leading provider of gastroenterology services with an unparalleled reputation for providing exceptional care to its patients. We look forward to partnering with the Gastro Health team to continue growing the business organically and through strategic add-on acquisitions.” – Geoffrey S. Rehnert, Co-CEO of Audax Group

Ambulatory Surgery Centers

Covenant Surgical Partners – KKR bought Covenant from DFW Capital Partners and other investors in August 2017.  “Covenant provides an important role in improving patient access and reducing costs for the health care system. We look forward to partnering with Covenant in building a premier professional services organization to support its affiliated surgery centers and physician practices,” said Jim Momtazee, Head of KKR’s Health Care investment team.

Urgent Care

CityMD was purchased by Warburg Pincus in April 2017 and they have already completed an additional acquisition in February 2018; CityMD purchased Stat Health from Spanos Jesse Barber.  The enterprise now consists of 100 locations.

“CityMD has established itself as a leading provider in the fast-growing U.S. urgent care market by creating an exceptional patient experience and providing high-quality treatment at significantly lower costs than traditional visits to the emergency room,” said In Seon Hwang, Managing Director, Warburg Pincus.  “We see meaningful opportunities for CityMD’s continued expansion and look forward to partnering with Dr. Park and the company’s management team in this next chapter of growth.”

Ophthalmology

Katzen Eye Group was purchased by Harvest Partners from Varsity Healthcare Partners in May 2017. Harvest has experience in industry consolidation in dental and physical therapy and is looking to grow the business through add-on investments.

Dermatology

ABRY Partners secured a majority stake in US Dermatology Partners (formerly known as Dermatology Associates) in May 2016 and have acquired 3 practices since then.

Brent Stone, a Partner at ABRY, said “We are excited to be partnering with Geoff Wayne and the Dermatology Associates team. Our partnership is based on a shared vision, and we look forward to providing both the capital and strategic and operational value to support Dermatology Associates as it continues to expand the platform and extends care to a broader patient base.”

Orthopedic Surgery

The Orthopedic Institute received an investment from Varsity Healthcare Partners in November 2017. The group plans to grow by acquiring clinically differentiated independent orthopedic practices and recruit physicians and surgeons in orthopedic subspecialties

Primary Care

Sverica Capital acquired RMS Healthcare Management, which provides management services to Med First, in August 2016. “We look forward to helping Med First expand its unique model into other rural markets in the Southeast.”  Gregg Osenkowski, Vice President at Sverica Capital added: “Med First is one of only a small number of primary care practices that are both Patient Centered Medical Home certified and offer the convenience of an urgent care model.”

Dental

Cordental Group was acquired by New Mainstream Capital in March 2017, and has already added 3 practices. New Mainstream also has investments in ophthalmology and dermatology and they see this as an opportunity to build a dental service organization (DSO) by acquiring practices around the country and using Cordental to “take the burden of running the business off the back of the dentist.”

Physical Therapy

10+ private equity platforms with private equity firms such as Advent International, Thomas H. Lee Partners, CI Capital and Sterling Partners.

ER Physicians

Integrated Care Physicians was acquired by BelHealth in August 2017. “BelHealth’s investment thesis is to create a regional, diversified platform with a physician-centric culture in the specialty provider space with an initial focus on hospital emergency departments. The emergency department is commonly referred to as the hospital’s front door – responsible for driving admissions and referrals to specialists and diagnostics. With high volume demands and reimbursement pressure, it is increasingly important for emergency department staff to move patients quickly and comprehensively through the department.”

Women’s Health

Sverica Capital Management acquired a majority interest in Women’s Health USA in August 2017. Women’s Health USA is a physician practice management firm focused on women’s health, including OBGYN and In Vitro Fertilization. Sverica was attracted by the joint venture operating model, which allows physicians to remain autonomous but also leverage the resources and expertise of the national practice management platform.

Behavioral Health

Bradford Health Services, LLC was acquired by Centre Partners in 2016 and subsequently added Red Oak Recovery in 2017. “Centre has a demonstrated track record of successfully partnering with management teams within the behavioral healthcare industry and maintaining commitment to clinical excellence within programming, which is of paramount importance to the Company’s mission,” stated Bradford Health CEO Clay Simmons.  “Our partnership with Centre provides a terrific opportunity to accelerate the Company’s growth and expand access to affordable care to a growing patient base.”

Home Health & Hospice

The Riverside Company invested in Bloomfield Hills, Michigan based ComForCare Health Care Holdings, LLC (ComForCare) in July 2017 and subsequently added CarePatrol in February 2018. “We anticipate significant growth across the home care space in coming years, and ComForCare is an elite provider of these vital services that should outperform the overall market,” said Riverside Partner Brian Sauer.

Conclusion

Given the depth and breadth of the physician market, as well as the strong desire for private equity firms to make investments where they believe they can add value, we anticipate that this trend will continue and that additional physician specialties will be added to the investment market in 2018.

“The majority of physician practices have a particular operating model—one that generally entails paying out the profit each year to their physicians—which creates a particular challenge for private equity groups,” said Christopher Helmrath, Managing Director, SC&H Capital. “Therefore, we frequently work with physician groups to help them understand the underlying, market-based value approach for practices that annually distribute their profits.”

He added: “We shape the terms of a private equity deal so that the physician owners maintain a level of income which makes them comfortable, while providing insight into how the private equity interests will be accretive to their overall business performance and value.”

 

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